Making efforts to recapture
lost market share through superior technology base

By SHABBIR H. KAZMIJul 31 - Aug 06, 2000

The paradigm shift in commercial banking, resulting from freezing of
foreign currency accounts (FCAs) in May 1998, has affected the foreign banks operating in
Pakistan significantly  to a large extent adversely. The recovery process, through
changed strategy, has started yielding positive results. Foreign banks are expected to
emerge stronger in the near future as Pakistan moves towards internet based banking.
Still, the competition with domestic banks is expected to remain ferocious.

Over the last many years, foreign banks have continued to command
nearly three-quarters of the overall profitability of the banking sector in Pakistan, in
spite of the tight manacles on their expansion. Foreign banks chiefly thrived on business
from top-tier multinational corporations and blue chip companies. The business of foreign
banks operating in Pakistan, in the past, also flourished due to FCAs and swap dollar
funds  which are no longer there.

The withdrawals from resident FCAs, in the shape of rupee, was quite
dramatic during the second half of 1998 which continued in 1999  though at a lower
pace. The bulk of converted amount eventually showed up in the banking system but the
share of foreign banks in total deposits reduced. Domestic banks were able to increase
their deposits and advances mainly due to an elaborate branch network. The lottery schemes
of Habib Bank, United Bank and Muslim Commercial Bank drained desposits virtually from
both domestic and foreign banks. With the loss of low cost deposits and advances,
profitability of a number of key players in the financial sector came under pressure in
1998.

Bank of America was the first to decide to close its operations in
Pakistan. As a result of global merger of ANZ Grindlays Bank into Standard Chartered Bank,
the two will become one in Pakistan also. The amalgamated bank is expected to emerge
financially the strongest foreign bank in Pakistan. Many banking sector analysts expect a
few more closures and more mergers and acquisitions. They estimate that within next five
years the number of foreign banks in Pakistan, will come down to less than a dozen.
However, these mergers and acquisitions will be aimed at attaining synergy rather than due
to declining profit margin.

The 21 foreign banks have a network of 85 branches largely concentrated
in big cities. They have assets of over Rs 250 billion and a deposit base of over Rs 180
billion. To achieve constant growth in size they have been using innovative approach.
Keeping in view the changing demands, the emphasis is more on personalized service,
electronic transfer of funds and sophisticated financial products, etc. They offer
innovative deposit schemes to remain competitive in resource
mobilisation.

Not a single foreign bank, out of 21 operating in the country, could
post a billion rupee profit for the year 1999. It is a spectacular decline from the
results registered for the year 1997 when three banks posted more than a billion rupee
profit. These were ANZ Grindlays Bank, Citibank and Standard Chartered Bank. In 1999 ANZ
Grindlays topped the list with a profit before tax of Rs 0.89 billion. It was lower than a
profit of Rs 1.36 billion the year before. Bank of America posted the second highest
profit of Rs 0.53 billion, down from Rs 0.69 billion in 1998. Profit of Standard Chartered
Bank was Rs 0.51 billion, close to that of Rs 0.53 billion for the year before. The banks
which posted higher profit in 1999, compared to the previous year, were ABN Amro Bank,
Mashreeq Bank, Citibank and Credit Agricole Indosuez Bank.

The freezing of FCAs affected foreign banks more adversely as they had
around 80 per cent of their total deposits in foreign currency in May 1998. Although the
ratio has dropped to 48 per cent by the end of 1999, foreign banks still have deposits
worth Rs 80 billion in foreign currencies  almost half of the banking sectors total.

Deposits of almost all the foreign banks dwindled in 1999. Citibank
carried forward the tradition of leading the rest by maintaining the largest deposits at
Rs 38.8 billion. However, it could not resist the decline  the deposits were Rs 49.3
billion in 1998. Deposits of ANZ Grindlays receded from Rs 28.5 billion to Rs 22 billion.
ABN Amro Bank registered a decline from Rs 21 billion to Rs 19.9 billion and Bank of
America's deposits dwindled from Rs 14 billion to Rs 12.7 billion.

The growth in advances from 1998 to 1999 is estimated around 12 per
cent, which is three and half times more than the growth in deposits. The borrowing by
manufacturing sector grew by 18 per cent which mainly represent Export Refinance. Foreign
banks advances portfolio grew by Rs 3.27 billion and represents 15 per cent market share.
Advances of domestic private banks increased by Rs 10 billion. Their exposure in export
refinance and to textile sector is greater than that of foreign banks. This is evident
from the fact that the borrowings of foreign banks from the central bank in 1999
represented 13 per cent of the total borrowings, while those of domestic private banks
represented 20 per cent.

Another important observation is that foreign banks hold four times
more exposure in chemical and pharmaceutical sector and five times more exposure in
Public/Government sector than domestic private banks. It is due to the domination of
multinational companies in chemical and pharmaceutical sector which have group
relationship internationally with the foreign banks.

American Express recorded 6.4 per cent decline in advances. It had
registered decline for the last three years also. The other banks which registered decline
in advances were: Bank of America (12.5%), Societe Generale (6.45%), Citibank (1.6%) and
Hong Kong & Shanghai Bank (4.39%). Despite a decline in the advances of Citibank, it
enjoyed the highest amount of Rs 21.85 billion.

Similarly, the investments of almost all the banks declined for the
year 1999. The fall in investment for various banks was: For Hong Kong & Shanghai Bank
51.83%, Emirates International 65.27%, Deutsche Bank 43.09%, Citibank 45.5%, Credit
Agricole Indosuez 23.3%, Standard Chartered 74.23% and Societe Generale 75.64%. Societe
Generale had shown a substantial jump of 34.71% in 1998. Among others, banks like ABN
Amro, ANZ Grindlays and Hong Kong Shanghai Banking Group have recorded decline in
investment over the last three years.

The growth of assets in case of Credit Agricole Indosuez was the
highest at 24.87%, followed by Habib Bank AG Zurich (10.79%) and ABN Amro (9.33%).
Standard Chartered Bank, whose assets had grown by 21.07% in the previous year, registered
a decline of 4.68% during 1999. Bank of Tokyo, whose assets had nearly doubled in 1998,
posted a decline of 6.54% for the year 1999. Emirates International also witnessed a
decline of 8.2% in 1999. Citibank, Hong Kong & Shanghai, American Express, ANZ
Grindlays and Bank of America witnessed decline in assets both in 1998 and 1999. Doha
Bank, Oman International, ABN Amro and IFIC had recorded increases in assets in the last
three years.

The operating cost of banking sector grew by 5 per cent. Shrinking
spread has forced commercial banks to rationalize their cost to income ratio through cost
cutting measures. During 1999, ANZ Grindlays and Deutsche Bank paid Rs 125 million and Rs
29 million as redundancy cost. Number of executives hired by the banks are higher in case
of foreign banks and they are highly paid as compared to their counterparts in domestic
banks. Despite the cost curtailment measures, foreign banks, as a whole, suffered as they
experienced fall in profit before tax.

The cost of funds for most of the banks came down during 1999. It was
15.08% for Societe Generale  being the highest among all the banks. The cost was the
lowest at 7.89% for Bank of Tokyo. The reduction was substantial for Oman International at
10.27% against 17.21 per cent in 1998. For the year ended 1999, Bank of Tokyo had the
lowest intermediation cost of 1.13%. whereas Deutsche Bank's cost was the highest at
10.98%.

The return on assets declined for most of the banks. For Societe
Generale, American Express, Doha Bank and Oman International it became negative. Mashreq
Bank showed a substantial improvement as the ratio doubled from 2.05% to 4.42% in 1999.
Emirates International and Bank of Tokyo registered the highest pre-tax margin of 27.5%.
While in the case of the former the ratio showed substantial improvement over 1998, for
the latter there was a decline. The ratio improved substantially for Mashreq Bank to
25.83% as against 14.89% for the year 1998. For ABN Amro the ratio was 17.99% for the year
1999 as opposed to 13.92% a year earlier. The pre-tax margin deteriorated for American
Express, Doha Bank, Oman International and Deutsche Bank.

While more than half of the total income of Mashreq Bank was non-fund
based, it was one-third for Deutsche Bank. The ratio of non-fund based income, as a
percentage of total income, improved for ABN Amro, American Express, ANZ Grindlays, Bank
of America, Doha Bank, Bank of Tokyo and Hong Kong & Shanghai Banking Corporation.
Standard Chartered Bank, Credit Agricole Indosuez and Habib Bank AG Zurich witnessed a
fall in their non-fund based income ratio to total income.

Fierce competition

During the post May 1998 scenario, domestic banks have emerged to be
ferocious competitors. Even the policies of central bank aimed at strengthening commercial
banks in general helped domestic banks more while supporting foreign banks marginally.
Some of these policies were: reduction in SLR, recovery of non-performing loans, exemption
of accrued income at the time of calculating tax liability and rules governing provisions
against doubtful loans. The reduction in return on deposits and lending rates also
improved the spread for domestic banks.

Half of the foreign local banks virtually reversed the provisions made
in the past or made no provision for the year 1999. The amount on account of provisions
came down Rs 0.1 billion for foreign banks and by Rs 1.82 billion in the case of domestic
private banks for the year 1999.

But, lottery schemes of Habib Bank, United Bank and Muslim Commercial
Bank was a major reason for movement of deposits from foreign banks to these banks. Some
analysts say, "It may not be wrong to say that foreign banks were the biggest
opponents of such schemes and ultimately the central bank succumbed to their
pressure." However, some of the foreign banks which came out with innovative
financial products rather than complaining about the changed scenario, witnessed slow but
gradual increase in deposits. One of the areas where foreign banks have been investing
heavily is technology to overcome the handicap of limited branch network. Almost all the
foreign banks are working actively on plans to introduce internet-based banking within the
year 2000. They have the advantage of global experience. However, despite their edge they
will face a tough competition from listed commercial banks.

Introduction of internet-based banking will largely depend on the
policies of GoP. However, the government cannot afford to delay its introduction in the
country for a long time. In the meantime foreign banks have consolidated their edge in
phone-banking, ATM network and on-line banking. Offer of these services has become a norm
at almost all the large-size foreign banks. While some of the banks have installed their
own ATMs, others have entered or are entering into strategic alliance with other domestic
and foreign banks.

Offering such facilities is capital intensive. However, helps in
reducing human resource cost, improving quality of services and above all bringing a bank
outside the four walls of conventional branch network. As foreign banks largely cater to
multinational companies and blue chip corporations they would be able to offer better
services and also cater to larger number of clients.

Another important development, over the years, is that small foreign
banks have developed their own niche market. The foreign banks of Middle East origin
concentrate more on handling remittance and international trade. Even the large-size banks
have added other services. Standard Chartered Bank, Citibank and Deutsche Bank provide
custodian service to foreign investors in capital markets. Citibank and Standard Chartered
Bank have started financing of cars and other durable. Earlier, Citibank had established
two separate entities, a housing finance company and an investment bank. However, later on
it sold its stake in investment bank to Jahangir Siddiqui and Company. Citibank has also
became a little more selective in distributing credit cards.

The credit card experience in Pakistan was like a nightmare. Therefore,
the new strategy being worked out is to replace credit cards with charged cards. On the
one hand it will help in bringing default to almost zero level and, on the other hand,
improve the cashflow of banks. A card holder would be allowed to purchase to the extent of
amount available in his/her account only. The banks will be able to issue more cards as
they will be exposed to hardly any loss. It will also be beneficial for the outlets
because the transfer against purchases can be almost instant.

According to some analysts foreign banks share about a quarter of
deposits and total advances within the banking system. Traditionally, the foreign banks
have focused on short term trade finance, targeting mainly low risk blue chip corporations
and high networth individuals. A couple of years back, these banks began making foray into
merchant banking, capital market operations and consumer/retail banking. The resources and
expertise of their global operations proved a valuable asset in these areas and many of
them were able to quickly capture large share in the capital market operations and
consumer/retail banking.

Outlook

The successful conclusion of agreements with multilateral lenders and
earliest disbursement can have a positive effect on the economy of Pakistan. In view of
the low yield on the assets, surplus liquidity, low demand for credit by the private
sector and the GoP's determination to bring down interest rates, the operating environment
for the banking sector will continue to remain challenging. However, the expectations are
the GoP's policies to revive the economy, both agriculture and industry, will increase the
demand for credit.

Foreign banks have enjoyed years of robust profitability, However to
survive in the changed environment they will have to come up with real innovative
financial products. At the same time they will have to identify new clients  other
than multinational companies and blue chip corporations. In the face of stagnant private
sector industrial growth and poor demand for credit, competition with domestic banks is
getting tougher with the passage of time. Domestic banks are also fighting for their
existence and are determined to intrude into an area considered to be an exclusive domain
of foreign banks in the past.

SIGNIFICANT EVENTS

In August 1999, a Middle Eastern Group bought the controlling stake
in Union Bank from Saigol Group. Union Bank has also purchased the Pakistan operations of
Bank of America. From January 2000, the Pakistan operations of the Trust Bank of Kenya
have been amalgamated with Metropolitan Bank. And ANZ Grindlays will be merged with
Standard Chartered Bank in Pakistan as per their global arrangement.